Efficiency, Risk and the Gains from Trade in Interbank Markets

65 Pages Posted: 10 Jan 2025

See all articles by Matthias Hoelzlein

Matthias Hoelzlein

University of Notre Dame - Department of Economics

Marc Dordal i Carreras

Hong Kong University of Science and Technology

Jens Orben

Deutsche Bundesbank

Abstract

Bank-to-bank markets play a central role in liquidity provision. However, by propagating shocks between banks, they may be a source of aggregate risk. We develop a quantitative framework to capture the welfare trade-off between efficiency and risk accompanying interbank market integration. In the model, we derive analytical approximations for welfare that depend on features of the interbank network and few key elasticities, we estimate using microdata on bilateral asset positions for the population of German banks. Our findings indicate that the current level of integration improves welfare by 1.33\%, while lender-of-last-resort policies reduce the welfare costs of short-term financial shocks.

Keywords: Bank Networks, Interbank Markets, Trade, Lender-of-last-resort

Suggested Citation

Hoelzlein, Matthias and Dordal i Carreras, Marc and Orben, Jens, Efficiency, Risk and the Gains from Trade in Interbank Markets. Available at SSRN: https://ssrn.com/abstract=5090723 or http://dx.doi.org/10.2139/ssrn.5090723

Matthias Hoelzlein (Contact Author)

University of Notre Dame - Department of Economics ( email )

United States

Marc Dordal i Carreras

Hong Kong University of Science and Technology ( email )

Hong Kong

Jens Orben

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

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